The Power of Connection: A Case Study on Endowment Draw
CEEP members regularly connect with each other to ask for insights on issues they are dealing with.
The following is an example of input asked for and given.
Question: From The Rev. David Dingwall, St. Paul’s by-the-Sea, Ocean City, MD
We are a small parish...ASA of 70 with an annual operating budget of $275,000-- $300,000. Our endowment is valued at $3 million. In recent years we have been subsidizing up to 50% of our operating budget from our endowment funds. This requires a draw of at least 5%. We have heard rumblings that the financial industry is recommending that non-profits look at limiting their endowment withdrawals to no more than 2% for 2014. To follow that advice would so gut our programming and staff that all we could offer would be Sunday services and maybe maintain a full time priest.
1) Are others getting the same type of advice?
2) Are there parishes with similar circumstances to our?
3) What are those parishes doing and do they have any advice/best practices to share?
Response: From Mr. Louis Fuertes, Financial Consultant
and Member of Christ & Holy Trinity Westport, CT
Many years ago, when I took introductory undergraduate economics, the joke was that if the professor asked you a direct question in class, you would be well-advised to answer either "Supply and demand" or "It depends". This comes to mind, because the answer to your question is, in fact, "It depends."
It depends on how your endowment is invested and on your expectations for the annual income generating capacity of your endowment (which is a function of your endowment investment policy as I will explain in a moment). It also depends on your expected future inflow of gifts and bequests to your endowment. Finally, it also depends on your goals/philosophy on maintaining your endowment over time or gradually distributing it to support operations, gifts to those in need, etc..
In our case (Christ and Holy Trinity, Westport, CT) we hope to maintain our endowment for the perpetual support of our parish rather than deplete it (N.B., a small minority feels that we should gradually liquidate our endowment by distributing it over time to those in our community who are disadvantaged, but this idea is not winning meaningful support).
Our budgeted endowment draw % is set at a level that is equal to the average annual expected rate of earnings for the assets in which our endowment is invested. In some years, earnings from our endowment exceed the amount of our draw, and in other years, the opposite is true. The discrepancy in any year between earnings and disbursements is not a concern to us given our long-term frame of reference. Over the long haul, it is our expectation that our endowment will not be depleted based on the amount of our draws. Under this policy, whatever endowment growth we experience will come from future gifts and bequests rather from retained investment income.
We have invested our endowment assets in a blend of equity, bond and money market mutual funds, with 75% in equity mutual funds, 20% in bond mutual funds and 5% in money market mutual funds. We have determined that this mix of investments has had a long-term average yield of almost 8%. Based on this finding and reflecting our desire to maintain our endowment in perpetuity, we have had a policy of budgeting a 7% draw on our endowment (this draw supports our annual operations and our property upkeep fund). Note that we have heard from many that a 5% draw is typical for not-for profit organizations, but to our thinking, the earning expectation for the underlying investment portfolio is more relevant that this "rule of thumb" (one of my business school professors noted that the acronym for rule of thumb is ROT!).
If our endowment were to be invested 100% in bond mutual funds, we would need to reduce our % draw to something in the 3% range given the historic yield on bond funds. If our endowment was invested 100% in money market mutual funds, the % draw would have to be reduced to less than 1% given the current yield on money market mutual funds. This explains my earlier comment that your draw % should reflect the expected earnings for the mix of assets in which your endowment has been invested.
I hope this sheds some light on the issues you raised.
Our community is within commuting distance of Manhattan and we are fortunate to have in our parish and on our Finance Committee a number of talented and knowledgeable financial services professionals who have helped us formulate our endowment management policies. None of them are urging us to reduce our endowment draw for the year to come. This is in part because we are not smart enough to know if the stock market or interest rates or any other key financial measure will go up or down in the year to come. Your endowment is of sufficient size that you (like us) can afford to have some years in which your draw is greater than your endowment earnings. Your draw % should most certainly reflect a reasonable average earning expectation for the assets you have invested in, assuming that you do not seek to deplete your endowment. If you are comfortable with the draw % given your investment policy, I would not advocate changing your budgeting practices each year based on the (probably bogus/highly questionable) expectations of earnings for the year to come from financial advisers.
Best of luck to you and your parish!